What’s really going on with Apple and its stock price in 2013?

Here we go again. Another Apple quarter that demonstrates long term strength in its business, and another quarter where Wall Street is waving its hands in the air claiming that the business is broken. Apple shares are down over $50 (10%) as I write this.

Always remember value investor Benjamin Graham’s famous expression: In the short term the market acts like a voting machine. In the long term it acts like a weighing machine. Today, the voting machine dominates. But over the course of many product cycles, those daily votes amount to nothing. That’s why the market is volatile, and why I focus on long term investing.

Apple reported the best quarter in its history. Sales of $54.5 billion were up huge compared to $46.3 billion in the year ago holiday quarter. Earnings were $13.81 per share versus $13.87 last year. But once you adjust for the 13-week quarter in the current year versus 14 weeks last year, earnings actually grew 7% year over year.

That 7% growth comes despite gross margin dropping, which is a fact of life when you introduce revolutionary products like the iPad mini. The growth also comes despite the fact that Apple built less channel inventory this year versus last year. Add another $700 million to Apple’s top line this year (or subtract it from last year) to get a more fair comparison.

Oh, and let’s not forget the new iMacs, which were severely supply constrained. Apple sold about a million fewer Macs than last year, which equites to over a billion dollars of revenue. Let’s add that to our adjustment of Apple’s so-called “broken” business.

Wall Street is worried about earnings growth. They see the revenue growth, but they focus on the gross margin decline of 6% year over year. Wall Street focuses on the short term “optics” of a situation. And in the short term, Apple looks weak because margin weakness seems to be offsetting the revenue growth.

But look at the bigger picture. The iPad and the iPad mini are canabalizing the PC market. This includes Macs, but it also includes Windows machines. This is the quote that I found most interesting out of last night’s conference call:

”I see cannibalization as a huge opportunity for us...On iPad in particular, we have the mother of all opportunities here, because the Windows market is much, much larger than the Mac market is. And I think it is clear that it’s already cannibalizing some and I think there is a tremendous amount more opportunity there. And as you know, I have said for two or three, actually three years now I believe that I believe the tablet market will be larger than the PC market at some point. And I still believe that. And you can see by the growth in tablets and the pressure on PCs that those lines are beginning to converge.”

And let’s not forget China. Is it totally lost on investors that China has become such a huge market for Apple that they need to break it out as a separate reporting segment? $6.8 billion of Apple’s revenue (that’s 12.5%) came from Greater China. Year over year growth was only a modest 67%. Hmmm, sure seems like a broken story to me.

Speaking of China - there has been a lot of attention on the possibility of a less expensive iPhone. Until last night, I was of the view that we’d see one of these lower cost phones hit sooner rather than later. But I’m not so sure anymore. Obviously Apple can sell a TON of iPhones in China at full price. So there is no need to rush out with a cheaper product. Apple’s style is to absorb as much growth as they can with higher priced products before launching lower cost versions. I don’t think we’ll see a less expensive iPhone in 2013.

The media and the investing community is fully absorbed in the bear story around Apple. That story is probably best told by the Nomura analyst. I don’t mean this in a good way, because I honestly feel the guy is insane to put forth this analysis, but it is what it is. And the market believes it right now.

Nomura’s position is that Apple isn’t growing any more. They’re an “ex-growth” story with earnings potential “capped” at about $50 per share. Without growth, people shouldn’t pay more than about 8x earnings (so $400) plus the company’s excess cash balance, which is another $89 per share. Round it up to $490 and you have their target price.

Why 8x earnings? Apparently because that’s what Microsoft fetches. And Microsoft is also an “ex-growth” stock.

Does anyone else notice the total insanity in this statement? We have the Mac market that has been outgrowing the PC market for a very, very long time. And now we have the iPad market cannibalizing the PC market, which allows Apple to grow at the expense of Microsoft. One company is slaughtering the other. Yet we are to believe both stocks should trade at a similar earnings multiple?

As Rene said to me earlier today, “It makes you think it's humans that are doomed.” Of course humans are emotional. Investors and analysts are human. Wall Street is all about the short term. Nobody wants to get caught being wrong on a stock in the short term. The pain of being short term wrong outweighs the pleasure of being long term right. That’s why we’re seeing so many negative reports.

I thought the comments from PiperJaffray and JP Morgan were much more rational. Piper calls for investors to return to the stock once the focus shifts to new products in the next 3-6 months. Makes sense. JP Morgan uses the beautiful line, “Apples and Oranges: Fundamentals and Investor Expectations Continue to Diverge”.

What’s really going on with Apple and its stock price in 2013?

I certainly wouldn't say Apple is "broken." But it is pretty clear that it is not an innovative company anymore and it's major market, the feature phone, may be under assault by more innovative and, critically, more diverse competition.

Statements like "when you introduce revolutionary products like the iPad mini" make us non-zealots cringe. What in G**'s Green Earth is "revolutionary" about the Mini? Is it a much better size than the clunky original iPad? Absolutely! Do I think it is a great product that will have lots of success? Absolutely. Will it be the best-selling tablet at any size? I don't know, but I'd bet within a year or two it will, because I really do think the smaller form factor is a lot better. But it will have enormous competition from well-funded, perhaps more innovative competitors (note perhaps...I don't have a crystal ball to know what innovations are coming down the pipeline from Google, MS, RIM, et al.). Revenues don't matter to Wall St., margins per share do. And those are flat. Sometimes, flat comes as a company retools before taking off again. This could happen. Sometimes, flat comes before decline. This could happen, too. Sometimes flat just stays flat. This seems pretty likely given the iPhone's defunct 'cool factor.'

Trading at the same earnings factor as MS, a company who's lifetime stock price growth still beats Apple's and who probably has the same probability (i.e., low) of being a "growth stock" over the next year, is a pretty fair.

to focus on margins is pretty stpd... as in Forbes top 100 Billionaires in the world ... all top richest from India made it on peanuts margins... the volume is what is important...which makes the huge profit on the long term... the only fools are investors here... because they trust all the nasty anal-ists and column writers... so those can fool investors and manipulate AAPL stock price for the Hedge Funds... which cash for their's retirement ... right now HF are... after making a huge profit on AAPL Puts loading tons of dirt cheap AAPL Calls and laughing at the investor's stupidity ... the only WHO is doomed are the ret@rds from SEC and US government ... but definitely NOT APPLE

I always make it a point to read Chris's writeups about stocks, I wouldn't consider myself very knowledgeable with respect to these advanced financials, so it's nice to get an in depth look from someone who knows what they're talking about. But honestly you completely lost me this time. Right when you said "which is a fact of life when you introduce revolutionary products like the iPad mini", it was kind of like that point in a movie that completely sucks you out of the experience. People can hate on me all they want, but the iPad mini wasn't revolutionary. From that point on the whole analysis read like a biased fanboys opinion to me. I'm sure it was well researched and informative but it just wasn't as credible any more. Should have left it out.

I think you're misreading the context. It was revolutionary in terms of Apple's iOS business to date. It was the first time they broke apart a product line and introduced a different device. Up until now, one iPhone, one iPad, one iPod touch.

Not only that, iPad mini was less expensive and with lower margins, which changed the average selling price (ASP) and that influences the stock.

For Apple, it was a big deal. When it achieves balance, we'll see how big it is beyond Apple. (My guess is they just mainstreamed the small size tablet, which would be huge.)

Also, throwing around a word like "fanboy" makes it hard to have a productive discussion. :)

The context wasn't articulated properly then. To me revolutionary is way beyond the scope of a single company and maybe even a single industry.

Yeah, I maybe could have came up with a better word myself than "fanboy". I wasn't trying to call him one, as these analysis are very unbiased which this one in total was as well. That line just changed the tone of it all for me.

No worries. It's your view and you're free to have it. The reason I think the iPad Mini is revolutionary is because it opened the doors to a huge flood of new sales. Apple didn't just launch another 7" tablet. They changed the form factor and made an incredibly light, thin and elegant iPad that everyone wants.

I get your comment ... I can think of plenty of reasons to say it was evolutionary, or just a form factor iteration. It's not important - it's all just a label. Fact is that it's selling like crazy, and that's what matters.

What you're not actually accounting for is the change in product cycle caused by the introduction of the iPad4 and iPad Mini. The existing sales bump in that timeframe should have caused a greater than seven percent jump in sales -- but it didn't. The market valuation for the period is spot on when a rolling inventory is accounted for as the release window for new products has been changed.

"But once you adjust for the 13-week quarter in the current year versus 14 weeks last year, earnings actually grew 7% year over year."

Are you really so defensive? Comments like "Nice try though" are what call your credibility into question. I tried to give you a point of reference to work against that you weren't considering -- and you respond less like an analyst and more like Rene's least favorite term (fanboi).

The bottom line is that the last 52-week cycle can't be reasonably used to compare year-over-year results since the change in release dates for the new iPad and introduction of the iPad Mini has created a different product cycle for Apple. The key here will be to see how sales progress through the Spring when previously the new iPad would have been released and now there doesn't appear to be a major Apple entry in that time frame.

Please, take the time to actually read the posts and respond to the content -- and trying to sound flippant really hurts your credibility.

Seven percent was the earnings increase. Revenue (as in sales) was up from 46.3 to 54.5 billion - that's 17%. Your sentence asking Chris to actually read the posts seems a little hollow under the circumstances.

I guess I could have just told you that you mixed up EPS and revenue, but I wanted to see if you'd figure that out or come back and tell me it was my own number. Just having a bit of fun. Sorry. I apologize.

The key here in terms of valuation, is what do you think the product cycle is now?

Steve seems to have held firm to an annual release schedule and product line that Tim is willing to bend, break and invent on the fly. Is the result of that going to be one where Apple is more willing to adjust their product line more often, or are they going to try to stick to their annual tentpole releases? If they're changing the tentpole date with the last release of the iPad Mini and iPad4, how will sales do between now and next fall?

It seemed before like Apple would release their flagship products, and then the market would take a whole year to catch up -- now it seems like Apple is willing to get back into the market when they feel the need. Is that a sign of strength, weakness, or just the new market reality?

Great article. It is amazing when "they" speak of innovation. Apple needs to be innovative vs "the others". The others have features, not innovation. Sure they have some nice features to a point, but not innovation. I'm still impressed by the iPhone 4 through iPhone 5. They don't have all the features, but they do have innovation in design and function. The others just implement, and wait for the next innovation to implement.

Wait so the others arent innovative they just have features?i am not sure what you mean.to me,this makes it seem like you duscredit any features not apple as being innovative. Has apple been innovative?yes they have.they molded the smartphone world to become what it is. However, to say others aret innovative is a bit harsh. windows phone for example, the interface is completely different than anything else. They have some really awesome features too, while not innovative, features are JUST as important as in many cases they add flexibility to their functionality. Windows phones people hub will beat out android and apples contacts apps any day of the week as they have innovated the way people interact with contacts. Webos, while dead now, revolutionized the way we could interact with our phones through gestures way ahead of its time. It also revolutionized multitasking and notifications. android might not have done as many big innovations but it has taken many ideas and innovated on them, making them better untill it finally got on top then it innovated. Google Now? That is one great innovation. My phone can remind me about tickets i have in my email, when the bus might be coming and when my sports team is playing. Thats innovation! Apple is not tje most innovative it IS innovative, but not the most and lately it hasnt been. Its more playing catch up now. I am rooting for apple amd will possibly be getting an ipad again soon. But as tecgnology and software evolve and as exciting as the smartphone world has become in the last year, apple hasnt really done anything to excite this year.

I see what you're saying Chris. However, it comes down to what they're gonna do with their money and differentiate itself from the competition. Right now, incremental updates to IOS isn't really helping Apple at all. Looking at BlackBerry 10 and IOS, it seems to me that Apple may have an unbalanced platform just looking at the various bugs with IOS like the "Autofocus" bug and how RIM is beating Siri's like features. There are many features like DST and how Do Not Disturb doesn't work. Not trying to trolling or anything, but it seems like it's either the Platform that's hard to work with or the engineers don't know what they're doing. Would like to hear your thoughts back.

I think the 20% decrease in Mac sales is being downplayed. Apple alleged supply problems, as if it was a positive thing. If that was really the cause, it is a sign of gross incompetence of both Apple and its fabled supply chain, and should not be underestimated.

If this happened to the Mac and to the iPhone 5, what will happen as Apple further expands worldwide or shortens its launch cycle? We are already seeing shortages of iPhone 5's in places like Brazil, where Foxconn actually has a factory, where the iPad Mini wasn't even lauched yet. Those voids are being filled by competitors and the image Apple worked so hard to build is being eroded.

AND, all the wisdom imparted here means absolutely nothing to the Quants and their machines and algorithms in the back rooms in Kuala Lumpur or Riyadh, or Manhattan. What can I do to make $1,000,000,000 TODAY !!! Not over the next 10 years - TODAY !!!

There are many bashing the market, analysts, investors over the seeming panicked reaction to Apple's results/guidance. And there are several spurious comparisons to how generously investors are treating Amazon and Netflix. Yes, the market is a weighing machine in the long run but in the short term we have to guess what the weight will be well in the future. Stock prices move first, then analysts expectations and then actual results. So near term panic can be proven right - or wrong.

When RIMM turned they were still pumping out growing earnings but some people started to see the signs that a turn was coming. Panicked selling on seemingly decent results was criticized at the time but look where we are now. I'm not saying Apple is heading down the same road as RIMM.

My problem with trying to gain comfort from a PE ratio is that Apple's earnings are so reliant on iPhone. Its a great product but it is inevitably losing its differentiation. I used to think the "platform" would make users sticky but surveys show greater willingness to switch from Apple to Android (and vice versa). This doesn't mean iPhone sales go in the tank but maybe it means sales slow and margins are under pressure. Does Apple's negotiating power with carriers diminish?

iPad and iPad mini are great and fast growing but would they be able to offset a profit decline from iPhone.

I don't doubt Apple's ability to create great, desirable products (though have we really seen this tested yet in the post Steve Jobs era?). But can they enjoy the same dynamics of a highly desired, revolutionary device that was also subsidized by carriers?

Re: "But look at the bigger picture. The iPad and the iPad mini are canabalizing the PC market."

Bingo. It's just the start of the post-PC era, and Apple is in a great position to own it with iPhone and iPad (and iCloud). Just like the PC era started in the early '80s and IBM was in a great position to own it with their IBM PC.

IBM lost the battle for PC market share for various reasons, and Apple lost PC market share by not licensing Mac OS soon enough. (Which may not have been a bad thing in retrospect. Apple is still the 3rd largest US-based PC manufacturer.)

Not wanting to put words into Chris' mouth but with a revolutionary product comes the costs of all the R&D, new parts, new assembly lines, training, etc. All those costs add up and will drop the margin for a while until sales reach a tipping point, aka ROI.

@Trodecke - what you say is true, however the real reason the gross margin is lower on iPad Mini is because they're offering it at $329, a whole $170 cheaper than the full sized iPad. Let's say the regular sized iPad has a gross margin of 40%. They'd have to drop the bill of materials by $100 (from $300 to $300) to maintain the same gross margin percentage on the Mini. That's pretty hard to do!

This is just typical financial markets behaviour. Apple came from a relatively low base so was able to grow at a fast rate, but now its growth is beginning to slow because it can only have so many customers who can only own so many devices. Then add to that competition from Android, economic slowdown in developed markets (= wealthy customers who can afford its products) etc. Since the market is measuring Apple against its past performance, it has disappointed in their eyes, even though it sold a lot of devices, because they expected its growth rate to continue indefinitely. All companies get treated that way, not just Apple.

Ok seeing as most of these comments are rediculos im going to clarify a few things.

First this is a tech blog, not blomberg. Most of what you have been citing is incorrect. Institutions dont care about fundementals. They run off of advanced algo's and simply easy to understand technical analysis.

Second, look at a weekly candle chart of the price, the stock has been in distribution since the summer. Price action was slowly turning. You dont just stop the titanic you have to turn slow it down before reversing it. Same can be said with the stock price. Momentum is down and its here to stay, yes it will make its pops to retest the techincal side of trading but we are not even close to the bottom of this.

Third, again this is a tech blog please stick to what you do best and report of the tech. You guys do a top notch job of it, keep it going and stick to your field.

Before all of you hope on the "this is your first post" nonsense, let me give my creditals. I am a former (retired) equities trader for Goldman and have adviced numorous high profile clients on how to develop systems of trading.

Tim and Peter sort of botched the call yesterday. Investors are selling because the forecast for this current quarter is down and they didn't do enough to put that into a longer-term perspective. They unintentionally told investors that the naysayers have been right. They left us with nothing but the conclusion that Apple is, indeed, slowing down. Tim, Peter, show some more fight and hold your team to higher goals!

So suddenly Apple is not innovating? Can someone tell me exactly what has Samsung or Google or Amazon innovated lately? Is making a phone with a 5 inch screen innovation? Making a cheap tablet that can access an app, music, and book store? Hasn't that been done? Apple started a revolution with the introduction of the iPhone in 2007. It doesn't surprise me at all that we now have a market saturated with touch screen smart phones. If Apple is supposedly doomed again, looks like everyone else is in the same boat. I haven't seen anything new or revolutionary from anyone. Just my take.

Wow! Reporting $46 Billion of revenue in one quarter is enough to send your stock down 12%. That explains how Wall Street can cause an economic downturn. Financial formulas and algorithms aside, that doesn't sound like a company whose stock you should be dumping. Unless they caught the stock on the way up and are trying to jump off the ride before they take a loss. Good article!

While you all scratch your heads to understand it, consider this. GoldmanSachs and others in the criminal gang, pulled the stock price down through high frequency trading. Why? Because most investment firms and traders have a automatic loss trigger at 10%. That means when a stock falls 10%, a sell order is executed to dump the stock and lock in the gains. That means they bought all available stock at 50 bucks cheaper. But why? Because they know something we don't know. Apple is not going anywhere and is a key part in the great surveillance machine. Watch what happens this year with Apple and technology this year and remember this.

"when you introduce revolutionary products like the iPad mini."
Maybe I missed something, but what was revolutionary about the mini? It was an iPad, only smaller. A change in scale is hardly revolutionary, especially when you're last to the small tablet market. It's a fine device (though not one I would buy), but there's nothing revolutionary about it.